While the U.S.
debates minor estate and marriage tax issues, which, whatever their merit, will have little economic impact, Germany, the world's third-largest economy, embraced last week a major overhaul of its tax code that will have sweeping impact. In one fell swoop, Germany went from being one of the most heavily taxed nations in Europe and an economy shackled in regulation to a low-tax Continental icon.
U.S. investors understandably may be inclined to yawn when presented with news of European tax regimes. But this is of more than academic importance. The tax reform package, which was passed last Friday (see
story), will help promote growth in Germany, the largest economy in Europe, which should, in turn, aid the Continent as a whole. While the tax package was expected, relatively few thought it would be passed this quickly, or be this broad, so the event has not yet been fully priced into the market. Thus, it will undoubtedly help boost markets not only in Germany, but elsewhere in Europe. Indeed, since the package was announced, Germany's benchmark
index has risen more than 3%.
"This is obviously a watershed event," says Michael Levy, managing director for global equities at
Deutsche Asset Management
and manager of this year's best-performing mutual fund in any class, the
European Equity Fund. He points to an expected increase in foreign direct investment, a rash of mergers and acquisitions brought on by the elimination of a tax on the sale of cross-holdings, the elimination of capital-gains taxes and the pressure it will put on other overtaxed, over-regulated economies in Europe to follow suit.
In addition, it brings momentum to the next big reform issue facing Germany: pensions. That reform will probably result in a lot more money entering the equity market in search of higher returns. This will in turn boost prices, as Germans begin to take advantage of expected tax incentives to save through mutual funds.
While many of the changes such as a capital-gains tax repeal won't occur for more than a year, some economists expect an immediate economic impact. Christel Aranda-Hassel, a London-based economist with
Credit Suisse First Boston
, estimates it will add half a percentage point of GDP growth this year to Germany. "That may not sound like a lot in the States, but that is huge for Europe," she says. Actually, I'm quite sure it is a lot more then we would see in this country from repeal of the estate tax, if it occurs. Are more people going to die to take advantage of it?
Levy, like many analysts and investors I have spoken with over the last couple of months, is extremely bullish about Europe. They see a number of ingredients for a strong rally in Europe over the next few months or year: strong companies with good earnings potential, countries undertaking structural reforms, more mutual-fund money entering the markets and a region with the beginning of an economic cycle comparable to the situation in the U.S. in the early 1990s. Mark Howdle, a European strategist for
Salomon Smith Barney
estimates a 20% increase in European shares over the next 12 months. And a cheap euro means U.S. investors can buy many stocks at a discount. The German tax-reform package is icing on the cake. "This just reinforces our bullish case for Europe," says Levy.
Already, Deutsche Asset's Levy has been rewarded for his bullishness. The investor class of his fund, which requires a $2,500 initial investment, is up 99.3% since the beginning of the year. Much of that increase is attributable to investments in some hot-performing IPOs the fund made in February. However, it is important to note the fund has also been the best performer in the overall European stock mutual-fund category over the last three months, beating the average of his rivals by more than 20 percentage points. (Levy's fund is up 14.5% over that period, while the average European fund is down 5.7%.) Sure the IPOs helped, but they were gravy.
Analysts agree the sector that is most certain to win from this tax reform is financials. However, with a rash of mergers and acquisitions potentially playing with the markets, investors may be wise to play it safe and stick to mutual funds. Other strong European mutual performers include the
Ivy European Opportunities fund, up 37.8% this year. It requires an initial investment of $10,000 and carries an expense ratio of 1.93%. The
Driehaus European Opportunity Fund is up 21.5% this year. It also requires a $10,000 initial investment and carries an expense ratio of 2.1%.
"Germany stuck out like a sore thumb when it comes to corporate taxes," says Michael Hartnett, senior international economist at
. Suddenly the thumb is a lot less swollen. Who knows, with the big issues getting resolved, maybe in a few years they'll turn to estate taxes.
David Kurapka's Global Portfolio column appears Mondays, Wednesdays and Fridays on TSC. In keeping with TSC's editorial policy, he does not own shares in any companies or mutual funds mentioned in this column. He also doesn't invest in hedge funds or other private investment partnerships. He welcomes your feedback at